Duties of Directors

Section 170 of the Companies Act

• Introduces the general duties in section 171 to 177 owed by a director to the Company and in certain cases, to the creditors of the Company.
• Identifies those duties which continue after a person ceases to be a director, namely the duties under section 175 (to avoid conflicts of interest) as regards ‘the exploitation of any property, information or opportunity of which he became aware when he was a director’ and section 176 (the duty not to accept benefits of third parties).

Section 171 of the Companies Act

This section states that a director must:

• Act in accordance with the company’s constitution, and
• Only exercise powers for the purposes for which they are conferred.

“if a director chooses to participate in the management of the company and exercises powers on its behalf, he owes a duty to act bona fide in the interest of the company.   He must exercise a power solely for the purpose of which it was conferred.   To exercise the power for another purpose is a breach of his fiduciary duty.”

See: Bishopsgate Investment Management Ltd (in liquidation) v Maxwell (No 1) [1994] 1 All ER 261.

What is a Proper Purpose?

A power can be exercised for any number of purposes, some proper and others improper.   The duty will have been breached for any number of purposes, some proper and others improper.  The duty will have been breached if the improper purpose is the driving force.

Section 172 of the Companies Act: A Duty to Promote the Success of the Company

This section states:

“(1)   A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole…

…(3)  The duty imposed by section 172 of the 2006 Act has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company.”

The key question here is did the director honestly believe that his conduct was in the interests of the company?  If there is no basis for the director reasonably to have believed this, then the court may well find him to be in breach of this duty.

Section 172.3.  The duty to promote the success of the company for the benefit of its members as a whole. This duty is displaced if a company becomes insolvent or borderline insolvent, at which point directors must have regard to the interests of the company’s creditors.

Re Item Software (UK) Ltd v Fassini [2004] EWCA Civ 1244 and Re Coroin Ltd [2012] EWHC 2343.

The duty to act in good faith and in the best interests of the company extends to a requirement that the director should disclose his own misconduct and other matters of which he is aware, including actual or intended damage to the company.

Section 174 of The Companies Act: A Duty to Exercise Reasonable Care, Skill and Diligence

The key sections of this provision are:

“(1)   A director of a company must exercise reasonable care, skill and diligence.

(2)     This means the care, skill and diligence that would be exercised by a reasonably diligent person with:

(a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and

(b) the general knowledge, skill and experience that the director has.”

Sub-sub section (a) contains an objective test – basically a minimum standard.   Sub-sub section (b) contains a subjective test, by reference to the particular director’s skillset (or otherwise).  The subjective test may raise the threshold, but it cannot lower it.

For example, a higher standard than the bare minimum would be expected of a finance director who is a qualified accountant, than from a finance director whose only experience is in payroll.

For an example of breach of this duty (at common law), see Dorchester Finance Co v Stebbing [1989] BCLC 498.   A claim by the company against two of its non-executive directors who were qualified chartered accountants.  The non-executive directors would often sign cheques in blank at the request of another director.  The court emphasised that the directors of a company had to act in good faith and in the interests of the company and display such skill as could reasonably be expected of persons with their knowledge and experience.  The directors had been negligent and were held to be in breach of their duties.

Professional advice should be taken by the director in the appropriate case, but it should not be blindly accepted by the director without question (Weavering Capital (UK) Ltd (In Liquidation) [2013] EWCA Civ 71).

Section 175 of The Companies Act: A Duty to Avoid Conflicts of Interest

The key sections of this provision are:

“(1)   A director must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company…”

There will be no breach if:

“(4)   (a)     the situation cannot reasonably be regarded as likely to give rise to a conflict of interest; or

          (b)     if the matter has been authorised by the directors.”

The Extent of the Duty to avoid conflicts of interest – Examples from Decided Case Law

• If a director resigns from a company and takes advantage of a business opportunity from which the company may have gained, he will be in breach of his duty, even if it can be shown that the company would never have pursued that business opportunity (Industrial Development Consultants Ltd v Cooley [1972] 1 W.l.R.443).
• However, a director who competes with the company after his resignation will not necessarily be in breach of this duty (Foster Bryant Surveying Ltd v Bryant [2007] EWCA Civ 200; [2007] Bus. L.R.).
• Tower v Premier Waste Management Ltd [2011] EWCA Civ 923.  A director’s liability for disloyalty in office does not depend on proof of fault or proof that a conflict of interest had caused the company any loss.  If a director obtains a business opportunity for himself, he will be liable, regardless of the fact that he acted in good faith or that the company could not or would not take advantage of the opportunity itself.

Section 176 of the Companies Act: A Duty not to Accept Benefits from Third Parties

This arose in Tower v Premier Waste Management Ltd, referred to above.  The “secret profits” rule (which overlaps with the “no conflict rule”) is again, essentially a matter of strict liability.

Section 177 of the Companies Act: A Duty to Declare Interest in Proposed Transactions

In essence:

1. If a director of a company is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, he must declare the nature and extent of that interest to the other directors before the company enters into the transaction or arrangement.
2. A director need not declare an interest if it cannot reasonably be regarded as likely to give rise to a conflict of interest.
3. A director need not declare an interest if the other directors are aware of it, or ought reasonably to be aware of it.

Section 182 states that if a director enters into a transaction or arrangement with the company without declaring his interest under section 177, he will be under an immediate obligation to declare that interest and failure and to do so will constitute a criminal offence.

Ratification. Can a Company Exempt a Director from a Breach of Duty?

Can a company exempt a director from a breach of duty?  In most cases, no.  A company cannot indemnify a director against liability for breach of duty except as specifically provided under section 232(2).

Evidence and Burden of Proof

The position was well set out by Lesley Anderson QC in the case of re Idessa (UK) ltd {2011] EWHC 804(Ch):

“I am satisfied that whether it is to be viewed strictly as a shifting of the evidential burden or simply an example of the well-settled principle that a fiduciary is obliged to account for his dealings with the trust estate… [counsel for the liquidator] is correct to say that once the liquidator proves the relevant payment has been made the evidential burden is on the Respondents to explain the transactions in question.  Depending on the other evidence, it may be that the absence of a satisfactory explanation drives the Court to conclude that there was no proper justification for the payment.   However, it seems to me to be a step too far [counsel for the liquidator] to say that, absent such an explanation, in all cases the default position is liability for the Respondent directors.   In some cases, despite the absence of any adequate explanation, it may be clear from the other evidence that the payment was one which was made in good faith and for proper company purposes.”

Another relevant case is:

“Re Mumtaz Properties Ltd, Wetton v Ahmed [2011] EWCA Civ 610, where a liquidator claimed for sums which he alleged were owing on directors’ loan accounts.  There were issues as to, amongst other things, whether one of the respondents had been a de facto director and whether another respondent (referred to as ‘Munir’) had received the benefit of an item debited to his loan account.

The Court of Appeal said:

“The approach of the judge in this case was to seek to test the evidence by reference to both the contemporary documentary evidence and its absence.   In my judgment, this was an approach that he was entitled to take.  The evidence of the liquidator established a prima facie case and, given that the books and papers had been in the custody and control of the respondents to the proceedings, it was open to the judge to infer that the liquidator’s case would have been borne out by those books and papers.

Put another way, it was not open to the respondents to the proceedings in the circumstances of this case to escape liability by asserting that, if the books and papers or other evidence had been available, they would have shown that they were not liable in the amount claimed by the liquidator.  Moreover, persons who have conducted the affairs of limited companies with a high degree of informality, as in this case, cannot seek to avoid liability or to be judged by some lower standard than that which applies to other directors, simply because the necessary documentation is not available.”

Remedies

Section 178 of the Companies Act.  Each of the statutory duties, except the duty to exercise reasonable care, skill and diligence, is enforceable as a fiduciary duty.

A director in breach of these duties may be liable to the company to pay compensation, restore the company’s property and rescind a transaction.  In addition or alternatively, a director may be ordered to account for any profits made as a result.

Section 212(3) IA sets out (non-exhaustively) the range of remedies available in misfeasance proceeding.  The Court must consider questions of causation as it would in any other Damages claim (re Simmon Box Diamonds Ltd [2002] BCC 82) and apportionment of responsibility as between directors.

Limitation Periods

The limitation period for a claim under section 212 is six years beginning on the date that the misfeasance of breach of duty complained of occurred.   The limitation period does not restart when the company enters administration or liquidation, because the provisions of section 212 does not create causes of action of themselves, but instead facilitate the litigation of those causes of action by parties other than the company (Goldfarb (Liquidator of Eurocruit Europe Ltd) v Poppleton {2007] EWHC 1433 (Ch)).

Where misfeasance or breach of duty is also potentially actionable under another provision of the Insolvency Act 1986, a claim for misfeasance may be brought even if the alternative claim is unavailable because of the passage of time.

In Re Palmier plc (in liquidation) [2009] EWHC 983 (Ch), the Court held that a claim against a director under section 212 was valid, even though it might, in principle, have been advanced as a preference claim, but for the preference not being made at a ‘relevant time’ (making the preference claim effectively time-barred).